Advancement Proceedings: A Litigation Expense Your Client Might Not Have Anticipated

When representing a client, it is helpful when law and logic align in an obvious manner. But alignment of law and logic sometimes appears murky at best, and often directly at odds. An example of this is when you need to explain that your client must pay for the defense of the officer and director it sued for wrongdoing.

A corporation is often obligated under the corporation’s bylaws or by contract to advance defense costs, including attorney’s fees, when its officer or director is sued in that capacity—even if the corporation is doing the suing. The logic behind the obligation is that corporations would be hard pressed to find qualified individuals to serve as officers and directors if those individuals then faced risks of being sued for acts they took while serving in those capacities. As the Delaware Supreme Court explained in Stifel Financial Corp. v. Cochran, the purpose of advancement is to “promote the desirable end that corporate officials will resist what they consider unjustified suits and claims, secure in the knowledge that their reasonable expenses will be borne by the corporation they have served if they are vindicated,” and to “encourage capable women and men to serve as corporate directors and officers, secure in the knowledge that the corporation will absorb the costs of defending their honesty and integrity.” 809 A.2d 555, 561 (Del. 2002).

And indemnification rights alone are not necessarily sufficient to protect officers and directors if the right to indemnification often cannot be assessed—or accessed—until a litigation matter concludes. In the meantime, a defendant can incur hundreds of thousands, if not millions of dollars in legal fees defending against such claims. Therefore, a corporation agreeing to not only indemnify but provide advancement of defense costs can give its corporate officer or director comfort that those fees will be paid as they are incurred as opposed to waiting years until the matter is resolved and a final right to indemnification is determined.

But what happens when those officers or directors act wrongfully toward the company, and the company decides to sue them? Then the officers and directors make a request for advancement—from the very same party that is suing them. And, generally, the corporation will have to agree to do so—especially if it is a Delaware corporation. Under Delaware law, very rarely does a corporation have a defense to paying advancement. Only if it can show that no causal connection exists between the underlying proceedings and the defendant’s official corporate capacity, as defined by the bylaws or contract, can a corporation evade a request for advancement. But that is rarely the case.

For the cases where Delaware corporations refuse advancement, Delaware has established summary proceedings that make it relatively simple to get fees awarded. The Delaware Chancery Court, where such proceedings are brought, will give priority to advancement suits and schedule them for a prompt hearing. And few defenses apply at this stage. If the contract or bylaws provide for advancement, the likelihood of avoiding advancement costs are slim. The only comfort a company takes is that the individual seeking advancement must provide “an undertaking to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corporation[.]” 8 Del. C. Section 145(e). But that determination will not be made in the company’s favor for months or years, if ever.

Making things more treacherous for the company refusing to pay advancement expenses is the fact that the officer or director can also seek fees for having to bring the claim for advancement, creating an upward spiral of attorneys’ fees for the corporation. Therefore, companies rarely dispute the right to advancement in Delaware. The availability of D&O insurance—which generally covers these advancement costs—also helps corporations swallow this bitter pill.

While corporations are hard pressed to dispute the right to advancement, they can dispute the amount of those advanced expenses—at least to some degree. For instance, if a defendant is represented by counsel who is also representing other defendants who are not entitled to advancement from the corporation, the corporation is only required to advance those fees and expenses that would have been incurred if the corporate officer or director were the sole defendant. If a defense or litigation activity only partially benefits the individual, then counsel must accordingly make a good-faith allocation of those costs and fees. And, of course, if a litigation activity only benefits the other non-entitled defendants, no advancement on those fees is required.

That said, these types of determinations are often hard for a corporation to win at the advancement stage. Under what has become known as the “Fitracks Procedures,” first set forth in Danenberg v. Fitracks, Inc., a senior Delaware counsel for the party seeking advancement prepares a detailed submission, certifying to the correctness of the amount of the advancement request. Senior Delaware counsel for the opposing party may then object to the amounts requested, certifying the detailed reasons why the amounts sought are not advanceable.

But a Delaware court will not engage in a detailed or granular review of “persnickety disputes” over fees at the advancement stage. After all, until it is clear which claims are indemnifiable and for whom, the court can’t decide a proper allocation on expenses. Therefore, “fights about details” should be left to the final indemnification proceeding.

In sum, before a corporation sues one of its officers or directors, it should be very confident that it will prevail. Otherwise, not only will the corporation suffer the expense of pursuing its unsuccessful claims, but it will suffer the expense of defending them, too.